Last month the Board of Governors of the Federal Reserve System (the “Fed”) issued Supervisory Guidance on Board of Directors’ Effectiveness, that applies to all domestic bank holding companies and savings and loan holding companies with total consolidated assets of $100 billion or more, and systemically important nonbank financial companies designated by the FSOC. The guidance includes five “Attributes of an Effective Board of Directors.”
- Set Clear, Aligned, and Consistent Direction Regarding the Firm’s Strategy and Risk Appetite. An effective board oversees the development of, reviews, approves, and periodically monitors the firm’s strategy and risk appetite.
- Direct Senior Management Regarding the Board’s Information Needs. An effective board directs senior management to provide directors with information that is sufficient in scope, detail, and analysis to enable the board to make sound, well-informed decisions and consider potential risks.
- Oversee and Hold Senior Management Accountable. An effective board oversees and holds senior management accountable for effectively implementing the firm’s strategy, consistent with its risk appetite, while maintaining an effective risk management framework and system of internal controls. (See below)
- Support the Independence and Stature of Independent Risk Management and Internal Audit. An effective board of directors, through its risk and audit committees, assesses and supports the stature and independence of the firm’s independent risk management and internal audit functions.
- Maintain a Capable Board Composition and Governance Structure. An effective board considers whether its composition, governance structure, and practices support the firm’s safety and soundness and the ability to promote compliance with laws and regulations based on factors such as the firm’s asset size, complexity, scope of operations, risk profile, and other changes that occur over time.
Attribute no. 3 above emphasizes accountability through compensation and is, therefore, most relevant to readers of this blog, including those not serving financial institutions (as these attributes are likely to become best practices). Here I quote from the Guidance.
A crucial aspect of holding senior management accountable is regular board oversight and evaluation of the performance and compensation of senior management. An effective board oversees and evaluates the development and implementation of performance management and compensation programs that encourage behaviors and business practices consistent with the firm’s strategy, risk appetite, and safety and soundness.
In addition, each component of senior management’s total compensation is informed by the board’s evaluation of the individual’s performance against performance objectives. An effective board approves clear financial and nonfinancial performance objectives aligned with the firm’s strategy and risk appetite for the CEO and business line executives and nonfinancial performance objectives for the chief risk officer and chief audit executive. Similar performance objectives are developed for other members of senior management. An effective board of directors also holds senior management accountable for the implementation of performance management and compensation programs that promote sound risk management, compliance with laws, regulations, and internal standards, including for conduct. Performance management and compensation programs, when combined with business strategies, discourage risk-taking inconsistent with the firm’s strategy and safety and soundness, including compliance with laws, regulations, and internal standards, and promote the firm’s risk management goals. [emphasis added]
As you will note, the emphasis in all five attributes is squarely on risk. Readers may recall my pre-2017 postings on the proposed rules under Dodd- Frank Act Section 956, “Enhanced Disclosure and Reporting of Compensation Arrangements” (re-proposed in 2016). It appears that the six federal agencies responsible for collectively agreeing to proposed and final rules may have accepted the suggestion of some commentators (including me) to address the requirements of Section 956 in agency guidance and supervision, not formal rules.
-Mike Melbinger, CompensationStandards.com March 25, 2021